Face value

Clean Breen

Ed Breen has made quick work of sorting out Tyco's mess

YOU can spot the grasping hand of Dennis Kozlowski everywhere at the Manhattan headquarters of Tyco, an industrial conglomerate whose disgraced former boss conjures up everything that went wrong with American business in the late 1990s. Photographs of Endeavour, Mr Kozlowski's exotic, antique yacht, still adorn the office walls. Boardroom oil paintings display his pretensions as a collector of fine art. An executive kitchen, once staffed with two professional chefs, gathers dust. But while the physical traces of Mr Kozlowski linger, his legacy is fading fast. Only a year since he started cleaning up Tyco, the new boss, Ed Breen, insists that the businesses Mr Kozlowski built are in good shape.

When Mr Breen accepted the top job at Tyco in July 2002, the company was in crisis. After abandoning a botched attempt to break the firm up, Mr Kozlowski had been charged with evading taxes on his personal art purchases, and promptly resigned. As the company struggled to fend off accusations of dishonest accounting, confidence collapsed and suppliers demanded cash on delivery. With big debt payments looming, Tyco's bankers got jumpy. Wall Street's carnivorous short-sellers smelt blood.

Pushed to the edge, John Fort, a board director and former boss, took temporary charge and tried to redeem himself by finding the right man to replace Mr Kozlowski. Mr Breen, an ex-Motorola manager who describes himself as an “operations fanatic”, promptly confirmed Mr Fort's good judgment by sacking him—along with the rest of the board and Mr Kozlowski's inner circle of 50 managers. As details dribbled out of the breakdown of controls that had allowed Mr Kozlowski to borrow hundreds of millions of dollars to buy property and other personal luxuries, Mr Breen cleaned up Tyco's corporate governance. He also reopened Mr Kozlowski's books.

The picture that emerged is of a company of many different pieces. At the heart of corporate Tyco in New York was a hyperkinetic mergers-and-acquisitions machine, where management controls vanished in the intoxicating 1990s. In some ways, Mr Kozlowski's team applied real discipline, handpicking thousands of firms to build strong market positions in dull and fragmented, but fast-growing businesses, chiefly medical equipment, plastics, fire and security systems and electronic components. “Tyco is pretty much number one or two in every market it is in,” says Mr Breen. “It owns all the powerful brands.”

But in other ways, corporate Tyco lacked discipline entirely. Top managers flagrantly abused the executive-loan scheme—actions that have since become the basis for criminal complaints. Even by the standards of the 1990s, salaries were outrageous. The head of human resources earned $2m a year, and annual bonuses ran to seven times basic pay. On the other hand, the “Dennis thing”, as Mr Breen calls it, did not spread beyond Mr Kozlowski's inner circle. At the operating level, Mr Kozlowski remained thoroughly parsimonious. Once acquired, Tyco's businesses were given a brutal, one-off round of job cuts, then left to fend for themselves.

Nor, despite the exhaustive efforts of short-sellers and their friends in the media, is there evidence that Tyco's accounting was particuarly deceitful. In December, an independent investigation reported no evidence of systematic accounting fraud at the firm. What Mr Breen describes as an “aggressive” internal audit of all Tyco's 2,150 operating businesses ended in April with a $1.5 billion charge to earnings. Of this, says Mr Breen, one-third relates to new accounting policies at ADT, Tyco's main fire-and-security brand. Another third comes from a general shift to more conservative accounting. Only the remaining $500m, says Mr Breen, consists of “mistakes” in Tyco's accounting between 1997 and 2002—a modest tally, by recent yardsticks. In all likelihood, the Securities and Exchange Commission will soon end its investigation of Tyco's books without taking any action.

Meanwhile, the government's routine audit of Tyco's tax filings should hold few terrors. Despite its offshore incorporation in Bermuda, Tyco's effective tax rate is still a relatively high 28%, suggesting that its tax-planning strategies were not excessive. The only big unknown facing shareholders is the potential damage from class-action lawsuits.

Down to detail

After obtaining fresh bank loans and selling new bonds in January, Mr Breen has now turned to managing Tyco's assets. He has made some big changes, ripping out the old team at ADT and splitting the plastics group into a separate business. By and large, however, Mr Breen will spend the next year working on the sort of detail that Mr Kozlowski neglected. Tyco buys $14 billion-worth of goods and services a year, but has no central purchasing department. Production is spread among too many factories. There is no company-wide strategy for information technology. Four headquarters (in New York, Bermuda, Florida and New Hampshire) will shrink to two.

In the medium term, says Mr Breen, the industries that attracted Mr Kozlowski should give Tyco annual sales growth of some 4-6%. Greater efficiencies should turn this into profit growth of 10-12%. As Tyco's businesses throw off cash, Mr Breen will pay down debts and rebuild creditworthiness. By the start of next year, he hopes to have restored the lustre to management—and to the share price.

After that, Mr Breen must wrestle with the same sorts of choices Mr Kozlowski faced to squeeze growth out of mature, industrial assets. Interestingly, he points to the same conclusion as the old rogue himself: buying yet more businesses to keep the process going. By this time next year, if all goes well, Mr Kozlowski's old M&A machine could have spluttered, in a modest way, back to life.